Tuesday, December 15, 2009

Matt Yglesias, Inflation Denier

Despite the theoretical connection between printing money and rising prices, and the empirical evidence staring him in the face, Matt Yglesias continues to raise doubts in the minds of the public over the threat of purchasing-power change. Here's Yglesias telling us up is down:

Inflation continues to be very low. But here’s how Daniel Costello reported it from Planet Money:

The core PPI – which excludes food and energy prices – rose 0.5% in November, more than expected. Leading the advance: truck and cigarette prices. Core prices are up 1.2% over the past year.

The news is unlikely to change the Fed’s decision on whether or not to keep interest rates at a record low Tuesday. But it does add to concerns the central bank’s loose monetary policy could lead to greater inflation and new asset bubbles down the road.

In 2008, the CPI increased 0.1 percent, way below the Fed’s 2 percent implicit target. In 2009 thus far, the CPI is set to increase by a number that’s higher than that, but still below the implicit target of 2 percent. So why, logically, would an increase from “way below target” to “somewhat below target” spark a concern about inflation? It would take a year or two of inclation above the target rate for the price level to return to its long-run trajectory. I doubt that if we had a year of 3.9 percent inflation followed by a year of 2.6 percent inflation that you’d hear people saying the Fed was worried about deflation. They’d say the Fed was glad things were getting closer to the target.

OK so Yglesias is making two separate claims here:

(1) Inflation continues to be very low.(2) Using core inflation as an index, we are below the long-run target of 2% per year.

Both claims are wrong, unless we very carefully choose our time frame. In terms of reaction to the PPI report, inflation is very HIGH--after all, the actual PPI went up 1.8 percent in one month (seasonally adjusted), which works out to annual inflation of about 24%; hardly tame. The core PPI went up 0.5% in one month--an annualized rate of 6.2%, triple the target.

Now of course, you can't judge a trend just by looking at a single month's reading, but again this drives me nuts when the news hook for a blog post is a very high reading, which is then reported as "evidence" for the low inflation. (!)

Anyway, let's look at Yglesias' second point, that we are still digging our way out of the actual price deflation of late 2008. Or rather, his point is even subtler--it has to be, because we already are above last year's price levels. What Yglesias is now arguing is that the current level of prices is below where it would have been, had we experienced "target" core inflation last year.

OK but what's so special about a two-year window? If we start in October 1971, when we were off the gold standard, and look at the 38-year change in core CPI through October 2009, then there is an annualized increase of core CPI of about 4.4%, assuming I did my Excel formula correctly. I think 4.4% is way way above the Fed's target of 2%, and since it's done that on average for 38 years straight, I think we are in line for some serious under-inflating.

Maybe Yglesias thinks I'm cherry picking by selecting 1971. OK if we go back to the start of FRED's core CPI series, in the 52-year span from October 1957 through October 2009, annualized core inflation has been just shy of 4.0% (again, subject to my quick Excel calculation in which I have 70% confidence). So the long-run trend is DOUBLE the official target, and it's been that way for 52 years. I'm too tired right now to think carefully through the compound growth issues, but I think that means we should have stable prices for 26 years straight in order to get back to where Yglesias wants us to be.

But I don't think Yglesias will agree with my assessment. He has done the equivalent of pointing out that since 1998, we have had no appreciable warming. Except, in Yglesias' case he is doing something more like saying, "Purchasing-power change halted in October 2008! Whence this 'consensus' on money and inflation?"

DISCLAIMER: I actually like Yglesias' posts, because he strikes me as sincere. I just think he is horribly wrong on this issue, being misled by people like Krugman whose sincerity I am not sure about.

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